Enabling equity crowdfunding opportunities for SMEs and entrepreneurs in Asia

United Nations Economic and Social Commission for Asia and the Pacific Digital Economy Task Force Enabling equity crowdfunding opportunities for SMEs and entrepreneurs in Asia

Acknowledgements The preparation of this paper, Enabling equity crowdfunding opportunities for SMEs and entrepreneurs in Asia, would not have been possible without the valuable contribution of Fundnel team members, Benjamin Twoon, Junxian Lee, Chris Fung, Bernie Chan and Michelle Tang. I would also like to thank Barbara Meynert and the Digital Economy Task Force for their comments and insights. In recent years, equity crowdfunding has emerged as a popular and powerful alternative financing solution. We have witnessed exponential growth of equity crowdfunding activities in the US and Europe, and this growth has fuelled a great number of SMEs with expansion capital. Together with growing internet penetration rates and appropriate support at policy level, we fully expect this trend to manifest across emerging Asian markets. Sam Ng Digital Economy Task Force of UN ESCAP And Co-Founder and CEO of Fundnel PTE Limited 30 November 2015 1 Page

Crowdfunding An Asian Perspective Introduction: Situation that SMEs and Entrepreneurs are facing in Asia As the global economy undergoes a period of correction and large corporations look to scale down on regional operations and refine expansion plans, the role that SMEs and entrepreneurs play in the new growth model for Asia becomes ever more significant. Small and Medium-sized Enterprises (SMEs) are widely recognised by policymakers as the backbone of Asia s economies, contributing to employment, innovation, economic growth and ultimately progress of the region. The Asian Development Bank s (ADB) SME Finance Monitor 2014 reports that SMEs account for more than 96% of total enterprises in Asian countries, and employed an average of 62% of total labour force in the region 1. Yet a poignant conclusion that comes from ADB s research, one that corroborates with other research in the domain, is that the major barrier to the survival and growth of SMEs is the limited access to bank credit. This is exacerbated by the reliance on a bank-centred financial system in Asia and the Pacific. Only 18.7% of total bank lending were to SMEs, and this has been a decreasing trend since the Global Financial Market of 2009. This results in an unserved market; in South and East Asia and the Pacific alone, approximately 9 million of all formal SMEs do not have sufficient access to finance 2. What about the Entrepreneurs and start-ups? Numerous pieces have been written about how the success rates of start-ups are low, and one major cause of this is the lack of financing 3. The reality is that many start-ups have no access to bank financing, having to resort to family and friends, along with seed and venture funds, to tide them through the initial years of setting up and growing the business. However, the advent of technology and alternative financing models has redefined the way SMEs and Entrepreneurs view fundraising, presenting them with a new solution that taps the wealth of the masses; introducing crowdfunding. Crowdfunding brings to the table a full suite of financing structures, such as Equity, Debt, Convertible Bonds, Revenue Sharing arrangements and Rewards; each with its own sophistication, return profile and appeal to the mass market of investors. In this paper, we seek to explore if Equity Crowdfunding (ECF) is a viable form of financing for SMEs and Entrepreneurs in the region and what the factors that support adoption are. By providing insights into case studies that have surfaced in recent times, we hope to highlight the impact that ECF has created for businesses in the world. We also share about the key drivers of ECF adoption, sharing our findings on the areas of internet penetration, access to capital and the regulatory encouragement. Lastly, we assess our findings, and conclude on how ECF can positively benefit SMEs and entrepreneurs in Asia, pointing out some of the limitations and challenges that countries in Asia have to address to tap on the potential that ECF brings. 1 Asia Small and Medium-sized Enterprise (SME) Finance Monitor 2014. (2015). 2 Closing the Credit Gap for Formal and Informal Micro, Small, and Medium Enterprises. (2013). 3 Graham, P. (2007, August 1). How not to die. Y-Combinator., 135 Startup Failure Post-Mortems. (2015, August 17). CB Insights. 2 Page

Part 1: An introduction to Equity Crowd-funding ( ECF ) and its evolution around the world ECF is the mechanism that allows private companies (not listed on the stock exchange) to raise funding by making an online offering of their securities to (1) private (accredited) investors and also to (2) the public retail investors (the crowd ). Investors become shareholders of the companies and have partial ownership, thereby standing to profit should the company perform well, or lose some (or all) of their investment should the company fail. Prior research on ECF indicates that start-up businesses seeking smaller investment quantums to kickstart and establish their businesses and products, stand to benefit the most from it. Subsequent follow-on funding may then in turn stem from other sources. Global crowdfunding (which includes equity, debt and rewards-based crowdfunding) experienced accelerated growth in 2014, expanding by 167 percent to reach $16.2 billion in funds raised, up from $6.1 billion in 2013 4. In 2015, according to Massolution s report, the crowdfunding industry is set to more than double this figure once again on its way to raising $34.4 billion 5. Massolution estimates that ECF in particular raises up to 40 times more capital per company than other forms of crowdfunding currently, putting it solidly in the spotlight as a viable means of capital raising. Total Crowdfunding Volume 34.4 Crowdfunding volume (US$bn) 16.2 6.1 0.5 0.9 1.5 2.8 2009 2010 2011 2012 2013 2014 2015F Figure 1 Total Crowdfunding Volume 5 4 2013CF Crowdfunding Industry Report. Massolution 5 2015CF Crowdfunding Industry Report. Massolution 3 Page

Crowdfunding volume by type 25,100 Volume (US$) 2,850 2,680 2,560 405 811 Donation Reward Lending Equity Royalty Hybrid Figure 2 Crowdfunding volume by type (2015) 6 The traditional method of fundraising and investing in a start-up is typically a disjointed process that involves corresponding across hundreds of private emails, calls and in-person pitch meetings. As fundraising online looks to carry on its impressive growth trajectory, early stage venture capital is being disrupted and moving online in a more public way. This essentially catapults the traditional practice of start-up investing into the new digital age. Forbes anticipates 2015/2016 to be the year that crowdfunding surpasses traditional angel investing and venture capital in volume. The World Bank also predicts that online fundraising via the crowd is set to reach USD 90 billion by the year 2020. Even then, this estimate is conservative; should the current exponential rate of growth persist, we will probably reach the USD 90 billion mark as soon as 2017. The recent focus and strong growth of equity-based crowdfunding in particular, drives the trend that it will collectively surpass traditional angel investing and venture capital as the strongest mode of start-up capital raising by 2020. 6 2015CF Crowdfunding Industry Report. Massolution; Lending includes peer-to-peer lending 4 Page

60 Annual Funding: VC vs Crowdfunding vs Angel (US$bn) 50 40 30 20 10 0 2009 2010 2011 2012 2013 2014 2015F Figure 3 -VC vs Crowdfunding vs Angel 7 Equity Crowdfunding a few global case studies Globally, the idea of ECF is not a new one. In fact it was used way back in the 1700s, when the famous musician Mozart needed to raise money to finance 3 concerts at a Viennese concert hall. Modern day ECF is once again jump-starting vibrancy in the early-stage business world. Legislators are increasingly beginning to identify with this momentum and are making steps to legalise and regulate this burgeoning industry and asset class globally. USA: The New York Wheel project, a 630 feet tall Ferris wheel, already underway in Staten Island has raised $450 million 8, led by former investment banker and chief executive Rich Marin. The remaining $30 million will be raised by ECF, making it the largest transaction crowdfunding has seen. North Capital Private Securities, the group tasked with crowdfunding the rest of the project will be using the site 99Funding to supplement share sales, in addition to its traditional broker-led strategy. United Kingdom: Crowdfunding VC Angel On 22 July 2015, E-Car Club became the first UK-based ECF project to provide a profitable exit for its investors when it was bought over by Europcar, a leading car hire company. The firm, which hires out electric cars on a pay-as-you-go basis, raised 100,000 from investors on CrowdCube in 2013 9. Just 2 short years later, its 63 investors are prepared to walk away with multiplied returns on their initial 7 Trends Show Crowdfunding To Surpass VC In 2016. (2015). Retrieved from https://www.crowdfunder.com/blog/trends-show-crowdfunding-to-surpass-vc-in-2016/ 8 Smith, R. (2015). Crowdfunding a $500 Million Ferris Wheel, With a Wall Street Spin. New York Times. 9 Root, A. (2015). E-Car Club's exit a positive sign for equity crowdfunding industry. Crowdsourcing.org. 5 Page

investment amount. E-Car Club s sale is a breakthrough for ECF operators worldwide, by demonstrating that these alternative forms of investments possess profitable exit strategies. China: Dalian Wanda Group, China s largest commercial property developer, raised over $780 million from investors on its crowdfunding app and online payments site 10 as of June 2015. Jointly launched with online payment service 99Bill, the application named Stable Earner No.1 allowed investors to commit as little as 1,000 yuan in ECF investments, and raised 5 billion yuan in just 3 days. South East Asia: Djenee, a start-up providing on-demand digital concierge services, broke records for ECF in Asia after raising over 300,000 euros on its first day 11. The Singapore-based start up ultimately went on to raise 418,731 euros through ECF, with the campaign concluding over-subscribed on July 30, 2015. Part 2: A study of key enablers of ECF A closer look at ECF in emerging Asian markets reveals 3 standout factors that have helped its recent proliferation. The presence of these factors have not only disrupted the traditional methods and processes of fundraising, but also look set to make the adoption of ECF more commonplace. Internet penetration Given that the process of ECF involves individuals investing into a company via an internet platform, it goes without saying that internet penetration must be a prerequisite to ECF. Our study below measures the extent of internet penetration s ability to influence the results of ECF, and if there is a positive correlation between internet penetration and funds raised via ECF. During our research, we sought to identify countries by internet penetration, and the corresponding volume of money raised for such jurisdictions. Figure 4 12 plots several countries with notable ECF volumes against internet penetration rates. 10 Fung, E. (2015). China s Wanda Group Raises $805 Million in Crowdfunding Push. Wall Street Journal. 11 Concierge startup Djenee smashes record for equity crowdfunding in Asia on FundedByMe. (2015). My Newsdesk. 12 Internet Users by Country (2014). Internet Live Stats. (2014)., Wardrop, R., Zhang, B., Gray, M., & Rau, R. (2015). Moving Mainstream: The European Alternative Finance Benchmarking Report. Ernst and Young and the University of Cambridge., 2015CF Crowdfunding Industry Report. Massolution (2015) 6 Page

Equity crowdfunding volume and internet users by countries (2014) 675 279 134 Crowdfunding volume (US$mm) Internet users (mm) 57 72 55 36 23 14 16 13 35 US UK Germany France Netherlands Spain Figure 4 Equity crowdfunding volume and internet users by countries (2014) Following on from this finding, we turn our eyes to Asia: see Figure 5 13, which details the key markets in Asia, their respective internet penetration rates and the 5 year average growth rate of these two measures. It is immediately apparent that numerous Asian jurisdictions have a high rate of growth of internet penetration, driving our perspective that the future of ECF in these countries is quite rosy indeed. 13 Digital Finance in Asia. Citi Research. (2015)., Internet Users. The World Bank 7 Page

Internet penetration and internet penetration 5 year CAGR by countries 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 86.3% 85.3% Japan 83.0% 68.5% 2.0% 0.4% 1.8% 4.0% South Korea 48.8% 48.0% 38.5% 31.0% 18.6% 17.6% 16.8% 7.3% 9.4% 9.0% 6.7% 9.0% Australia Malaysia China Vietnam Philippines Thailand India Indonesia Internet penetration Internet penetration growth rate Figure 5 Internet penetration and internet penetration 5 year CAGR by countries Access to Capital; freedom of capital flow The inherent friction in accessing capital has adversely affected the private financing industry, whilst simultaneously driving the spread of ECF; in China, growth has slowed for traditional private investments, yet crowdfunding volume has reportedly reached US$110m in 2014 and the number of ECF or ECFrelated platforms have grown to over 2,000. According to crowdfundinsider.com 14, a reputable online website reporting on ECF developments, the proliferation of crowdfunding in China is due to three critical factors: 1. High cost of debt for SMEs: it is a widely known fact that SMEs in China continue to face challenges in assessing bank credit, and even if such credit is obtained, the cost of debt is high. This has led to a flourishing shadow banking industry; ECF can arguably be considered to be a subset of shadow banking in China. 2. Insufficient investment opportunities for private investors: PRC investors are, at law, prohibited from investing in stock exchanges outside of China, and are restricted to only investing in the Shanghai and Shenzhen stock markets. With an asset management industry that still has some ways to go in terms of sophistication, PRC investors have diminished investment choices, apart from bank deposits. This is another factor enabling the proliferation of ECF in China. 14 Liang, Z. (2015). Crowdfunding in China: Potentials, Challenges, Risks and Solutions. Crowdfund Insider. 8 Page

3. Government restrictions are placed on the amount of local currency PRC nationals are allowed to place in investments outside of China, and the reverse is also true of foreign investors purchasing RMB. The other half of the equation of this sanction means that SMEs in the PRC have great difficulty obtaining foreign investors. With a resulting shortage in viable investment options deployed and received, ECF gains recognition as the new-age de facto option for savvy businesses and investors alike. The examples above highlight the case for ECF in China, yet the high cost of debt, insufficient investment opportunities, and enforced capital controls are factors not unique to China, but a common occurrence in many emerging economies in Asia 15. So long as these factors remain prevalent, market forces will continue to push for alternative means of financing, at the benefit of incumbent and incoming ECF operators. Regulatory Encouragement: regulatory framework Has Regulation caught up with Technology? An overview of the Another factor we consider to be crucial in enabling ECF is the regulatory environment. After all, if the consequences of operating an ECF platform are criminal sanctions, then that may outweigh any perceived financial gains obtained through operating an ECF platform. The disruption caused by the internet and ECF has created a legal void in which regulators are only, until recently, attempting to fill. In a regulatory landscape where no laws relating to ECF exists, the default position taken by many governments has been to regard ECF in the same manner as a securities offering by a company to the public. This usually requires companies to meet specific benchmarks (for example, having a certain financial record, a viable business plan, or be of a certain caliber), and at the same time, publish extensive prospectuses explaining the company s background. In the context of SMEs, satisfying existing requirements are oftentimes neither practical nor possible. As a result, many ECF platforms have and continue to exist in legal grey areas. A notable example is China, where, notwithstanding unclear and low levels of guidance on the legality of crowdfunding platforms, there are reportedly over 2,000 peer to peer online lending platforms 16. The good news for both operators and investors is that governments and corresponding regulations are now catching up to the needs of ECF platforms. Numerous jurisdictions have begun to regulate ECF activities, while others have commenced public consultations. On a generous average across jurisdictions, new regulations give a cautionary green light to the operation of ECF platforms, subject however, to two typical criteria: (a) cap on the amount of funding a company can raise through ECF, and (b) cap on the amount of funding an investor may invest. As the ECF market evolves and matures, the direction is clear in that the regulatory landscape has been slowly, but surely, catching up with progress in the ECF industry. 15 Wright, T. (2015). Debt Piles Up in Asia, Threatening Growth. Wall Street Journal. 16 China Archives - Crowdfund Insider. (n.d.). Retrieved from http://www.crowdfundinsider.com/tag/china/ 9 Page

A short summary of the regulatory landscape of key jurisdictions in Asia are set out below 17 : Jurisdiction Governing body and applicable regulation Company side Restrictions Investor side Additional features Malaysia Governing Body Securities Commission of Malaysia Applicable Regulation Capital and Markets Service Bill 2015 ( CMSB ). Developments Six ECF platforms are expected to commence operations pursuant to the bill in late 2015 to early 2016. Companies may only raise up to RM 3 million (~US$856,000) in any 12 month period and RM 5 million (~US$1.42mm) in total through ECF platforms. Retail investors can only invest a maximum of RM 5,000 (~US$1,210) in each company and no more than an aggregate of RM 50,000 (~US$12,100) each year. Angel investors can only invest a maximum of RM500,000 (~US$121,000)within a 12-month period There is no restrictions on sophisticated investors. CMSB imposes a six-day cooling off period, within which they may withdraw the full amount of their investment. 17 All currencies rates are calculated as of 31 Dec 2014 10 Page

Thailand Governing Body Thailand Securities and Exchange Commission; Capital Market Supervisory Board ( SEC ) Applicable Regulation Capital Market Supervisory Board No. TorChor. 3, 7 and 8/2558 (May 2015). For offerings to retail investors, the funds raised must not exceed THB 20 million (~USD$608,000) within 12 months from the initial offering, or THB 40 million (~US1.22mm) in aggregate. For offerings to nonretail investors, there is no maximum of the offering. Retail investors can only invest up to THB50,000 (~USD$1,520) per offering of each issuer, and a maximum of THB500,000 (~USD$15,200). No restriction on an amount a professional investor can invest. Developments Since SEC published the new rules relating to ECF which went effective in May 2015, there is no active ECF operator in Thailand Singapore Governing Body Monetary Authority of Singapore ( MAS ) Applicable Regulation Securities and Futures Act (Cap. 289) Developments MAS has released a consultation paper in February 2015 Company is restricted to advertise the offer. Investors must be institutional investors or accredited investors which includes individuals with personal assets in excess of S$2mm (~US$1.51mm), or such investors income is not less than S$300,000 (~US$226,600) in preceding 12 months. Retail investors are not allowed to invest via ECF platform. 11 Page

to facilitate securitiesbased crowdfunding South Korea Governing Body Financial Services Commission (South Korea) Applicable Regulation Crowdfunding regulation has only been recently introduced through the passing of the Financial Investment Services and Capital Markets Act (the Act ) on July 6 2015. The Act will be enacted on January 2016. Startups can raise no more than 700 million won (~USD$640,000) per year through crowdfunding portals Each individual can invest no more than 5 million won (~USD$4,570) per company per year. n/a 12 Page

Part 3: Conclusion The potential that ECF presents, as evidenced by the case studies in both the West and in Asia, are the synergies of collective wisdom, and the power of collaborative capital. What is perceived as too-risky for traditional funding sources such as Financial Institutions, Private Equity or even Venture Capital, can instead be supported by smaller commitments and ticket sizes from the crowd, powered by a combined intelligence harnessed on a common platform. This also reduces the maximum capital outlay required of each investor and limits the capital at risk to an amount that each investor is amenable to, lowering the barriers to entry to private investments, thereby increasing the probability of a company securing the financing it requires. With the internet as a technological enabler acting as a bridge between SMEs/entrepreneurs and investors, the previously opaque and inaccessible domain of private investments is now liberated and democratised; quintessentially, individual investors now have access to and the power to decide upon which companies deserve capital allocation. This, in principle, should unveil a new wave of capital that is available to SMEs and Entrepreneurs in Asia; especially important for companies that would have no access to traditional forms of finance due to the nature of their industry or company lifecycle. Yet this potential is not without practical challenges, as countries in developing Asia might not have the required infrastructure and knowledge on how to ride on the benefits that the ECF brings. With some Asian countries (Thailand, Indonesia, Philippines and India and many others) hovering below the average global internet penetration rate of 45% 18, the inability to access the internet precludes society from leveraging ECF platforms. Also, the benefits of ECF might not be apparent to SMEs and Entrepreneurs in countries that have lower knowledge of financial literacy, preferring to tap the trusted and traditional sources of financing from banks. Adoption of this new model of finance will require a combination of basic access to the World Wide Web, and a process of educating SMEs and Entrepreneurs about ECF and the benefits it brings. Furthermore, there is the important conversation on Regulations; how financial watchdogs will monitor this ecosystem and protect investors. At one end of the spectrum, some countries in Asia (South Korea, Malaysia and Thailand) have allowed the mass market to access ECF investments, while at the other end, Singapore has only allowed this for accredited investors. Given that different countries in Asia are at different stages of developing their regulatory frameworks, with country-specific regulations, this could see different levels and rates of adoption, limiting the impact that ECF brings to the region as a whole, especially when adopted as a cross-market funding tool. There are also other factors worth exploring which, as the development of ECF in Asia progresses, would be meaningful to observe. One of them is the level of financial literacy of investors in the country, and how that impacts their view of ECF. The other factor is that of social media penetration, and as a natural extension of internet penetration, the mechanics that drive the marketing and promotion of ECF opportunities on the internet. Notwithstanding these limitations, ECF is ultimately a tool and platform where all investors - retail, accredited and institutional - can leverage the ubiquity of technology to reach out to unchartered territories and identify investment opportunities all around the world. More than just a form of disruptive technology, it is a technology-driven enabler that improves the efficiency and proliferation of capital allocation in support of SMEs and Entrepreneurs, helping these companies to be identified and funded by investors that believe in the business and team. We are at the cusp of a new model of financing that could plug the 18 Miniwatts Marketing Group (2015). Internet Usage Statistic. Retrieved from http://www.internetworldstats.com /stats.htm 13 Page

funding gap that SMEs and Entrepreneurs face. Coupled with the vantage point we have obtained from the case studies and enablers in this paper, there is strong collective belief that if harnessed correctly by respective Governments, ECF is capable of supporting the tremendous growth of SMEs and Entrepreneurs in Asia. 14 Page